The Tim Ferriss Show: Master Investor Ed Thorp on How to Think for Yourself, Mental Models for the Second Half of Life, How to Be Inner-Directed, How Basic Numeracy Is a Superpower, and The Dangers of Investing Fads | The Tim Ferriss Show (#604)

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Key Takeaways

  • Most people don’t understand the difference between averages and the way things are distributed in a population
  • Two things to practice to become more numerate according to Ed Thorp:
    • Elementary statistics (nothing complicated)
    • Elementary mental calculations (learn how to multiply small numbers in your head)
  • The most common and easiest way to use the rule of 72 is to calculate how long it takes something to double
    • The rule of 72 tells you why investing for the long term pays off and why wasting money pays off in a negative way
  • “I would say that the more pressure there is in which you might have to spend down your capital at some future point, probably the less likely you are to try to become a long-term investor in something that’s quite risky.” Ed Thorp
  • Who should invest in hedge funds today? 
    • For Ed, it’s wealthy, tax-exempt investors (individuals or institutions)
    • “I might say the collection of all hedge funds together, taken as a pool, are not attractive. That is, if there were an index, a cap-weighted index of hedge funds would not be an attractive asset class anymore, my opinion.” – Ed Thorp
  • Do preventative things and make sure you’re not missing something important (colonoscopies, skin cancer checks, etc.)
    • You can work out and be fit, but if you miss routine checkups, you’re leaving a big risk factor open for yourself
  • Other-directed versus inner-directed
    • “There are a lot of, I’ll call them inner-directed extroverts. By inner-directed, I think of yourself as having your own independent moral and ethical compass, a set of rules for living and guiding yourself.” – Ed Thorp

Key Books Mentioned

Intro

  • Edward O. Thorp (@EdwardOThorp) is an author, hedge fund manager, and one of the world’s best blackjack players
    • What can you learn from one of the world’s best blackjack players? Think long-term. Become more inner-directed. Learn a little bit more about probability statistics and Mathemagic
  • Host: Tim Ferriss (@tferriss)

Conversing About Numeracy

  • “When you, for example, talk to an attorney, most often, they’re really good with words, but they make elementary numerical mistakes, get a decimal in the wrong place and they won’t realize it.”Ed Thorp
  • News article numbers are repeatedly presented with ridiculous precision
    • However, that doesn’t mean that a poll or survey represents what people really believe
    • It might have been badly worded, the sample might be too small or have been biased
  • Another fundamental thing that people don’t understand is the difference between averages and the way things are distributed in a population
    • The average does not necessarily tell you anything about the distribution
    • We often deal with people by thinking about averages, instead of dealing with the person and all their unique qualities (and where they might be in the distribution)
    • “So when I meet somebody, I don’t think about them as being in any particular category. I think that as far as I’m concerned, they’re my equal and they know things I don’t know.”Ed Thorp
  • How to train yourself to become more numerate?
    • Ed recommends a book called “Mathemagics” by Arthur Benjamin
  • Two things to practice to become more numerate according to Ed Thorp:
    • Understand elementary statistics and how it works (nothing complicated)
    • The second thing is elementary mental calculations
      • You can figure out a lot of things in your head very easily if you get used to it
      • Learn how to multiply small numbers in your head
      • Like in finance, compound growth calculations in your head are very useful
  • Determining the day of the week for a specific date
    • You can figure it out in under a minute in your head
    • You just have to memorize how it works 

Elaborating on the Rule of 72

  • It’s a well-known rule in real estate circles
  • The most common and easiest way to use the rule of 72 is to calculate how long it takes something to double
    • You take the interest rate per year (suppose it’s 8%)
    • Divide 72 by 8, and you get nine years (the doubling time)
    • It can be applied to anything that increases exponentially (population, charges, loans, etc.)
    • If you use numbers below 8%, the doubling time ends up a little shorter than the rule tells you, and vice versa
  • “One of the handy mental things that you’ll find very useful is to know what the doubling powers are: 2, 4, 8, 16, 32, 64, 128, etc.”Ed Thorp
    • The rule tells you why investing for the long term pays off and why wasting money pays off in a negative way
  • Why are people bad at taking the longer-term perspective? 
    • Most people seem to be focused on what’s immediately around them and what’s happening
    • When it’s about them, they can’t see clearly. When it’s involving one of their friends, they usually see a lot better

What “Long-Term” Means in Terms of Absolute Years

  • “I would say that the more pressure there is in which you might have to spend down your capital at some future point, probably the less likely you are to try to become a long-term investor in something that’s quite risky.” Ed Thorp
  • The lifetime consumption problem – a well-known problem in financial economics
    • No one answer is going to satisfy everybody
    • Thorp’s view is that if you have enough capital so you’re comfortable, then this problem largely goes away.
    • Stick it in for the long run at a high rate of return and let it go
    • If you can let it grow to some extent (without spending), then you have the luxury of being able to invest for a very long time
    • Of course, you can spend some of it as time goes by, but you don’t have to spend so much as to eat into it heavily

How One Might Get an Edge in Hedge Fund Investing

  • “The hedge fund world has gotten very big. When I first started, there were only a couple of hundred hedge funds.”Ed Thorp
  • Originally, “hedge fund” meant a private limited partnership that invests in financial products (real estate loans, equities, commodities, etc.) 
    • It was very wide-ranging, kind of a catchall for “private limited investment partnership”
    • The basic structure is that there are a group of limited partners and a managing general partner
    • The limited partners just collect whatever returns they get and the managing general partner charges a fee
  • Now, the asset class of hedge funds is very large (about $3 trillion) 
    • That is almost 2% of the entire net worth of the United States 
    • And it has perhaps 10,000 or so hedge funds in it, and they range in size from the multibillion-dollar ones down to a few million dollars 
  • It’s pretty hard to run one now, and start it up, because of all the costs
    • “So the hedge fund world used to be a much better place for individuals to invest. Now it’s better for institutions.”Ed Thorp
  • Who should invest in hedge funds today? 
    • For Ed, it’s wealthy, tax-exempt investors (individuals or institutions)
    • “I might say the collection of all hedge funds together, taken as a pool, are not attractive. That is, if there were an index, a cap-weighted index of hedge funds would not be an attractive asset class anymore, my opinion.”Ed Thorp

Physical and Mental Fitness

  • Ed Thrope is 89 years old, but Tim compliments him that he looks like he’s 60
  • How does Ed Thorp control his weight?
    • He made a habit of getting on the scale and observing his weight
    • Depending on the number, Thorp would opt for a healthy salad instead of a burger that day
    • “But anyhow, I would say that a person can develop their own feedbacks, whatever those are, and use them. And measurement is important because you want facts on which to base what you do instead of hopes, beliefs, wishes, so on.”Edward O. Thorp
  • There’s a simplistic notion of apples and pears in people
    • An apple is somebody that tends toward getting a big belly when they gain weight
    • This is not healthy because you hold fat around your internal organs
    • Never get that pot belly – one of the key things on his list related to health
    • “So all I have to do, I can look down, if I see anything that isn’t flat down there, I know I weigh too much. That’s another awareness: needs to change things.” – Edward O. Thorp
  • Do preventative things and make sure you’re not missing something important (colonoscopies, skin cancer checks, etc.)
    • You can work out and be fit, but if you miss routine checkups, you’re leaving a big risk factor open for yourself
  • Supplements for mental health
    • Thorp doesn’t take much of them because their evidence isn’t strong enough
    • One thing that he found that worked well was bone supplements 
    • He was able to reverse osteopenia after several years
  • Thorp’s tips for reducing stress
    • One thing that works for him is listening to music (classical, old songs and music from movies, soft jazz)
    • Also, going for walks and thinking about whatever 
    • “My mind just kind of runs free and I’ll — maybe after this conversation, I’ll go for an hour walk and I’ll think about the things we said and what I wish I said, but forgot, so on.” – Ed Thorp

Avoid Unnecessary Risks

  • People are roaming around without masks and they are acting like COVID is over, but why risk and catch it?
    • A lot of people will run that red light because they can just barely get through, and every once in a while, one of them gets in an accident
  • The Unthinkable” by Amanda Ripley
    • During September 11 attacks people made different decisions; some saved their lives and others died
    • Amanda Ripley identifies a three-stage process when we find ourselves in great danger:
      • Denial (this can’t be happening)
      • Deliberation (acceptance that this is happening)
      • Decision (doing something)
  • What to do when somebody starts shooting in the crowd?
    • You have very little time to decide what to do
    • Ed Thrope would drop to the ground and then figure out what to do next because you’re a small target
    • Nowadays, people end up in these situations more often than we would like to admit 
    • If you have some idea about how you’d act in some of those situations, there is more chance of coming out of it with less loss 
  • E.g. Ed Thorp knows what he would do in case there was an earthquake and he was in his tall office building
    • Most of us don’t like to think about these things and prefer to think about happy things
    • He used to run on roads but soon stopped because of risk (statistics show that runners are being hit by cars on roads) 

Think for Yourself and to Attempt to Start From First Principles Whenever Possible

  • Other-directed versus inner-directed
  • “The Lonely Crowd” by David Riesman, Nathan Glazer, and Reuel Denney
    • The book explores the idea of “inner-directed” and “other-directed” people
    • Other-directed people tend to base their values on the people around them 
    • They conform, go with fads, with a majority vote on things
    • And inner-directed people are more self-deciding about things 
    • They are associated with introverts, but not exclusively
  • “There are a lot of, I’ll call them inner-directed extroverts. By inner-directed, I think of yourself as having your own independent moral and ethical compass, a set of rules for living and guiding yourself.”Ed Thorp
  • Other-directed people tend to decide on their morals by imitating others
    • Those people are afloat without a compass
    • It’s harder to be that kind of person because they don’t have anything inside that helps them feel a sense of worth
  • Even though it’s simplistic, Thorp believes this kind of reasoning is very useful
    • It breaks people down into 16 major categories (depending on the choice in each of four dimensions) 
    • And then it gives you a general description of a pure type 
    • Most people very much like one of those 16 types 
    • And when you find that out, you can understand a lot of things about them very quickly

 

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